Ideas on planning for dairy profitability cycles

Jim Salfer

Published in Dairy Star November 20, 2009

Finally – it looks like milk production nationally is beginning to drop and prices are slowly recovering. The year 2009 will likely go down as the most unprofitable year ever for dairy producer. Genske Mulder & Company recently summarized their Arizona clients’ first six months of financials. The average producer lost $3.86 per cow per day. In Minnesota, Farm Business Management instructors also summarized profitability for some of their larger dairies for the first six months of 2009. They showed a loss of over $200 per cow over this time. It doesn’t matter what number you look at, the dairy industry lost a tremendous amount of net worth in 2009. No doubt, over the next year all producers will need to work with their trusted advisors to develop a game plan on how to re-build equity and on how to better survive the next downturn in profitability.

All businesses go through profitability cycles. The time to develop a plan to prepare for and take advantage of the next downturn is when profits are up. Here are some ideas to consider during your planning:

1) Remember: The rules have changed. We have tighter lending restrictions than in the past. It clearly appears we will have less predictable costs in the future, especially feed and energy costs. If the United States wants to continue to grow our export market, we will have wider fluctuations in milk prices because of the many factors affecting that market. These include the value of the dollar, Oceania supply, and the strengths of other countries’ economies.

2) Calculate your cost of production on a regular basis. Either work with a financial consultant such as farm business management or develop your own record keeping system. Use these records for more than tax planning. Successful farms of the future must be more nimble in making management changes and an accurate ongoing assessment of their financial situation will be important.

3) Develop a plan with your lender(s) and financial advisors on how to re-build your equity. Make sure your debt is structured correctly and take advantage of current low interest rates. Work with your vendors and lenders to pay down any open accounts. Don’t forget about personal debt such as credit cards.

4) Evaluate working capital needs. Records show that dairy producers traditionally have lower working capital than many other agricultural enterprises. This is likely due to a consistent income and historically more consistent margins than other commodities. With wider fluctuations in income and expenses, we need to re-evaluate this strategy. According to Dale Nordquist from the Center for Farm Financial Management, the recommended working capital:gross income is 25%. Working capital:gross income for dairy farm enterprises has never averaged more than 20% since 2000 (Figure 1). To maintain this ratio, working capital of $675 to $1000 per cow will be required in the future.

5) Evaluate current capital purchase/tax management strategy. Are capital purchases decisions made based on a long term business strategy or are they made solely to avoid taxes? It is always intelligent to minimize taxes but we may have to re-think the strategy of purchasing capital items just to minimize taxes in a year of high income. David Kohl, Virginia Tech agricultural economist recommends that producers “stash the cash” when income is high. This may be even more important in the future.

6) Annually benchmark your business against the best in your class. There continues to be a wide variability in profitability between producers. Figure 2 shows the net return for Minnesota dairy enterprises by profitability cohort. Across years of good milk prices and poor milk prices, the bottom 20% of producers consistently have negative returns. Examine your areas of weakness and develop a profit improvement strategy. An excellent website to compare your profitability against others in the industry is the University of Minnesota Center for Financial Management. The URL is: http://www.finbin.umn.edu/.

7) Evaluate personal living expenses. Many families in the United States have had to decrease their standard of living over the past few years. In years of higher incomes, there often is a tendency to increase the family living standard. And, that becomes hard to change during lower income times. Families should consider developing family budgets and prioritize living expenses.

Dairy producers have been going through a very difficult year. This has forced everyone to re-evaluate their business strategies. As we move into 2010, commit yourself to be better prepared for the next downturn in the dairy industry.

Figure 1. Working capital to gross income ratio. (Note: Years are in descending order from left to right.)